The Network/Merchant Interface: Interchange

Around the world, the most popular proposal relating to credit cards in the last several years has been to regulate the price that networks charge merchants for credit card transactions. The proposals – implemented by regulators in Australia, the EU, Israel, Mexico, and the United Kingdom – target a problem distinct from spending and debt. Those regulators worry that a high interchange fee for credit card transactions – one that is not passed through from merchants to credit card users – will increase the overall level of consumer pricing. That possibility is troubling if customers that use cheaper payment systems implicitly subsidize customers that use credit cards. Subsidizing credit card users creates a perverse incentive for credit card use at the point of sale.

Still, it is not clear how regulation of interchange will affect credit card use. Put differently, a reduction in interchange would not necessarily reduce credit card use. It is possible that a reduction in interchange could cause more merchants to accept credit cards, thereby increasing overall credit card spending. In the American market, for example, Discover has been lowering interchange rates in recent years to secure more merchant acceptance of its card. Conversely, an increase in interchange might reduce card use. If the market is functioning properly, we should assume that the networks are pricing interchange at levels designed to maximize the growth of their networks.